Reason Foundation

Cramdowns Could Return

There has been a lot of talk over the past several weeks about a plot by federal and state regulators to force banks to modify as much as $20 billion in mortgages for their role in robo-gate. I had a lengthy blog post about it last week recapping most of the issues.

One big part of this is a long-time desire by some in the administration to force modifications and their attempt to push the issue in the back door. Cramdowns were shot down in 2009. HAMP has failed. But the proposed new servicing rules issued to banks (aside from the $20 billion penalty) could create a legal path to cramdowns by another name. From American Banker:

[If] state attorneys general prevail in settlement talks with the five largest mortgage servicers, Durbin may finally get his wish - with a twist. In addition to pushing banks to reduce mortgage debt in bankruptcy, the 27-page draft agreement would give Elizabeth Warren, the interim head of the Consumer Financial Protection Bureau, new authority to determine if all borrowers should receive a principal writedown.

At issue are provisions in the draft settlement agreement, which must still be negotiated with the banks, which are designed to pressure banks into offering principal writedowns. If the agreement were finalized in its current form, banks would be required to set up a special loan modification process for bankruptcy cases. They would be encouraged to reduce principal to the fair market value of a property while other unsecured debt is discharged or, as part of a Chapter 13 plan, lower the borrower's interest rate to zero for five years and then reamortize at a market rate for 25 years after that point.

That, industry observers said, is largely the same as what Durbin was seeking.

"It kind of is like the mortgage bankruptcy cramdown," said Phil Swagel, a visiting professor at Georgetown University and a former Treasury Department official in the Bush administration. "It seems inappropriate. The robo-signing is terrible and any misdeeds should be dealt with ... but it seems this is an end run around Congress."

The banking industry isn't the only one that sees the similarity. A spokesman for Durbin said the draft agreement was close to what the Illinois Democrat was trying to accomplish.